Midcap and smallcap focused equity mutual funds shine

With mid-cap stocks surging on the bourses, equity mutual funds (MFs) that invest in them have gained at a rapid pace. Equity MFs that have exposure to mid and small-cap stocks have increased by about 13.5% on an average in the past six months.

They lagged only funds that invest in technology and pharmaceuticals stocks during the period. The BSE small-cap and mid-cap indices are among the best performers in recent months.

While the BSE small-cap index soared 14.5% in the last three months, the mid-cap index jumped 11.2% for the period. This enabled small and mid-cap equity funds to gain 12.1% in three months, the best performance among widely traded asset classes.

Though the markets gained in the last one year, the performance was largely driven by large-cap stocks. While the benchmark Sensex advanced about 5.7%, stocks in the small and mid-cap space were among the worst performers in the past year.

"Mid-cap stocks became very attractive as valuations came down," said Sankaran Naren, chief investment officer, equities, ICICI Prudential MF. "Mid and small-cap stocks were beaten down badly during July-September. They have picked up strongly as prices became cheap," a senior official with a leading fund house said. Cyclical sectors including capital goods and interest-rate sensitive segments have started doing well on the hopes of a recovery in the economy, officials said. "There has been a return of risk appetite among investors," a senior official said.

The performance of mid-cap stocks and funds would now depend on interest rates, officials said. "Good mid-caps would do well if interest rates come down," Naren said. "If the interest rate environment changes it would help mid-caps," officials said.

Small and mid-cap funds typically increase and fall at a faster pace than benchmark indices. This is largely because the beta (a measure of volatility) of small and mid-cap stocks is usually higher than blue-chip shares.

Mid-cap funds were the worst hit when the markets tanked following the global financial crisis in 2008. They slipped to the bottom of the performance charts losing 40% to 55% between September 2008 and March 2009. The recent improvement has boosted the performance of mid-cap and small-cap funds over the long-term. Though these funds have posted measly increase in the one-year period, they have beaten large-cap as well as diversified equity funds in the three-year and five-year timeframe.